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The Risk That Could Drive Oil Prices Higher in a Hurry

Marco Bello

By Nick Cunningham, Oilprice.com

July 11, 2017

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The latest rally in oil prices ran up against a wall yet again, and the same fears about oversupply have not receded in the slightest. The expectation from most oil analysts is that there is very little room on the upside for oil prices and that we will have to wait until 2018 at the earliest before the market gets closer to “balance.”

But the one major wildcard for oil prices is geopolitics, which, however unlikely given the degree of supply overhang that still exists, could send prices up. But how high? The latest blockade of Qatar, which has mushroomed into a regional political crisis in the Middle East, would have caused a severe spike in oil prices in the past, even though Qatar is a relatively minor producer. However, the simmering standoff not only failed to register, but occurred at a time of falling oil prices.

If a crisis involving heavyweight oil producers was shrugged off by the market, it is hard to imagine some other event causing a sharp price spike, even if more barrels were on the line.

But that is exactly what some analysts are afraid of, warning that the markets are overlooking some potentially massive geopolitical problems looming just over the horizon.

"Venezuela's 2 million barrels of oil a day could literally go any day. Mexico looks poor. Azerbaijan's in trouble. China's own production is collapsing rapidly," Neil Dwane, the chief investment officer of European equity at Allianz Global Investors, told CNBC last week.

"One only has to have one mistake and the only thing you'll be talking about all morning is oil at $120."

Herman Wang of S&P Global Platts agreed with that sentiment, although he expects the price spike to be less severe. "There are plausible scenarios where you could see, perhaps not $120 a barrel, but an elevated oil price, say $70 to $80 on some of these geopolitical and some of the supply concerns. Venezuela certainly is a mess right now," Wang told CNBC's Squawk Box last week.

But there are a few reasons why some analysts would roll their eyes at the prospect of triple-digit oil prices in the near future. After all, oil inventories are still sky-high even if they are starting to come down; U.S. shale production has roared back, adding roughly 0.5 mb/d since late last year; and Libya and Nigeria have restored around 400,000 barrels per day of disrupted production. Not only that, but sharper gains are expected to be forthcoming from the U.S., Nigeria and Libya, while other long-term projects in Canada and Brazil are set to add production this year.

However, not all of that is guaranteed. The U.S. shale rally recently hit some bumps in the road. More importantly, the geopolitical uncertainty in unstable countries such as Libya and Nigeria could quickly knock production offline once again. For example, Reuters reported that heavy clashes took place in Libya on July 9, underscoring the fact that the country’s recent calm is highly fragile.

Also, the peace in the Niger Delta is also starting to look rocky. Former militants, according to Reuters, are unhappy with government promises, and have threatened a return to violence. "This peace is a graveyard peace," a local chief in the Niger Delta told Reuters. "Nobody can assure anybody that nothing will happen in the Delta." Nigeria is aiming for 2 mb/d of production in August, which would be the highest total in a year and a half, and almost double the low point from last year.

There is also the vaguer and more uncertain variable of the recent ascendance of Saudi Crown Prince Mohammed bin Salman, who has brought a more hawkish approach to Saudi foreign policy. The escalation of confrontation against Qatar is one clear consequence of that. So is the war in Yemen. More conflicts could arise from a more belligerent Saudi government. “We contend that the region could be subject to more volatility and heightened risk,” as a result of Mohammed bin Salman taking over as crown prince, RBC wrote in a note last month.

But it is Venezuela that could be the mother of all black swan events. As Neil Dwane of Allianz Global Investors mentions, Venezuela has already seen the near total breakdown of society, and its oil production of 2 million barrels per day (mb/d) could unravel. It still seems unthinkable at this point, but becoming more likely by the day. Already, Venezuela’s oil production has eroded sharply, falling to 1.96 mb/d as of May 2017, down from 2.375 mb/d in 2015. Meanwhile, Venezuela’s refining industry is in shambles, forcing the country to increasingly import gasoline to avoid fuel shortages.

The street protests in the South American country just marked their 100th day, and show no sign of slowing down.

The oil market is rather depressed and subdued at the moment, but could awaken at moment’s notice if large volumes of oil production are disrupted from some unforeseen event.

This article originally appeared at OilPrice.com. Read more from OilPrice.com: